Cyient To Tata Tech: JPMorgan's Key Picks In Engineering, R&D Space As Growth Set To Widen

India's engineering, research and development services space is set to see its growth premium widen, led by the recovery in the automobile sector after the valuation and the growth premium slipped early this year, according to JPMorgan.

However, the global brokerage warned that the "premium won't go back to the levels seen earlier, due to persistent telecom weakness," in a note on Nov. 25.

Under this widening scenario, JPMorgan said that it continues to like its "growth heroes", which include KPIT Technologies Ltd. and Persistent Systems Ltd. The brokerage sees recovery play in L&T Technology Services Ltd. and Cyient Ltd.

Tata Elxsi Ltd. and Tata Technologies Ltd. are among the last picks in the space for the global brokerage.

ER&D companies offer services to enterprises on activities that involve the process of designing and developing a device, equipment, assembly, platform, or application.

The key catalyst for KPIT Technologies could be the announcement of one large deal out of the four in the pipeline, it said. For L&T Tech and Cyient it could be a strong third quarter and retaining the fiscal's growth guidance and margin targets, JPMorgan said.

ER&D companies have underperformed information technology peers by 23% this year, due to a shrinking growth premium, the note said. This has been led by continued weakness in telecom and slowdown in autos driving delays in deal ramps and closures, it said.

"We believe auto weakness is more cyclical and transient and growth should accelerate from next year, as original equipment manufacturers shift from electrical vehicles to hybrids, while telecom weakness seems more structural in nature."

The acceleration in auto should drive expansion in growth premium for research and development space over IT, that should also result in valuation premium expanding, it said.

Shares of KPIT Tech have fallen by 7% in the last 12 months and 8.3% on a year-to-date basis, while Persistent Systems stock has grown by 89% and 62%, respectively.

Eleven of the 17 analysts tracking KPIT Tech have a 'buy' rating on the stock, four suggest a 'hold' and two have a 'sell', according to Bloomberg data. The average of 12-month analysts' price target implies a potential upside of 27%.

Of the 40 analysts tracking Persistent Systems, 19 have a 'buy' rating on the stock, nine suggest a 'hold' and 12 have a 'sell', according to Bloomberg data. The average of 12-month analysts' price target implies a potential downside of 8%.